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QE Hints Or Lack Thereof Key To Thursday's ECB Statement

By: Chris Ciovacco | Wednesday, June 4, 2014

The European Central Bank has telegraphed most of what will be contained
in Thursday's statement.

The wild card, in terms of market reaction, most likely lies in if/how
the ECB addresses the subject of quantitative easing.

From an investment perspective, the markets have most likely priced in
the core portions of the Thursday's ECB statement; QE is the exception.

Since QE can impact stocks, bonds, commodities, and currencies, the market
may be disappointed if the ECB fails to hint at the possibility of implementing
a QE program.

What's The Problem In Europe?

There are numerous problems, including persistent low inflation and a wide
spread between lending rates for borrowers in different countries. Borrowers
are paying higher interest rates on loans in Italy and Spain relative to Germany
and France. The economies in Spain and Italy are much more in need of the economic
benefits of low borrowing rates, which can spur building, investment, and hiring.
We have touched on the problems associated
with low inflation in the past; an issue on the ECB's short-term radar.

The Telegraphed Expectation

The head of economic research at Open Europe, Raoul Raparel, handicapped the
widely expected key moves to be announced by the ECB. From Forbes:

Cut the main interest rate to 0.15% (from 0.25% now).

Cut the deposit rate to -0.1% (from 0% now). This will be an unprecedented
move.

Announce a new Long Term Repurchase Operation (LTRO) focused on boosting
lending to small and medium sized businesses. The term will be between
3 and 5 years, rates will be reduced if banks provide evidence of a pick-up
in lending (see below for a useful Nomura graphic on this, the 1st and
2nd options are most likely).

Buy The Rumor, Sell The News

If there is little-to-no mention or hinting of the possibility of future QE
in the ECB's statement, the odds of a negative "sell the news" reaction increase.
From Bloomberg:

Yields on bonds from Belgium, France, Italy and Spain have fallen to
records in the past month amid speculation policy makers meeting tomorrow
may add unconventional measures, such as quantitative easing, in addition
to lowering interest rates... "We see a high risk there will be disappointment," Cosimo
Marasciulo, Dublin-based head of government bonds and currencies at Pioneer
Investment Management Ltd., which oversees about $244 billion, said yesterday. "The
market is looking for some form of QE, or at least an opening of the door
to QE, and we think the ECB will be reluctant to do this. Those who bought
bunds and Italian bonds on expectations that QE in the euro zone was very
close may be disappointed."

Investment Implications - Don't Expect A QE Announcement

The odds of the ECB announcing plans to begin a QE campaign are not zero,
but they are very low. We are looking for hints or "we are open to" language
in the statement. Experienced traders and money managers will tell you that
it is not the news that matters, but the market's reaction to the news. They
will also tell you predicting how the market will react to any given news event
is difficult at best. Therefore, our strategy will be the same as it always
is...we will make decisions based on observable evidence in the stock, bond,
commodity, and currency markets, which means we will wait for the market's
reaction, rather than trying to anticipate it.

Until Something Changes...

The observable evidence has called for a mixed allocation of stocks (SPY)
and bonds (TLT), with stocks getting the bulk of the exposure. What do we mean
by "observable evidence"? Our market
model uses numerous inputs, such as the moving averages shown below.

The current profile is not a high-risk of an prolonged equity plunge profile,
which means something has to change for the stock market bears to take control.
News events are often catalysts for change. We have two big events left on
this week's calendar; the ECB announcement and Friday's labor report in the
United States. If we monitor the markets and incoming data with an open mind,
we can maintain the required flexibility to stay within the confines of a prudent
investment allocation.

Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com.

All material presented herein is believed to be reliable
but we cannot attest to its accuracy. Investment recommendations may change
and readers are urged to check with their investment counselors and tax advisors
before making any investment decisions. Opinions expressed in these reports
may change without prior notice. This memorandum is based on information available
to the public. No representation is made that it is accurate or complete. This
memorandum is not an offer to buy or sell or a solicitation of an offer to
buy or sell the securities mentioned. The investments discussed or recommended
in this report may be unsuitable for investors depending on their specific
investment objectives and financial position. Past performance is not necessarily
a guide to future performance. The price or value of the investments to which
this report relates, either directly or indirectly, may fall or rise against
the interest of investors. All prices and yields contained in this report are
subject to change without notice. This information is based on hypothetical
assumptions and is intended for illustrative purposes only. THERE ARE NO WARRANTIES,
EXPRESSED OR IMPLIED, AS TO ACCURACY, COMPLETENESS, OR RESULTS OBTAINED FROM
ANY INFORMATION CONTAINED IN THIS ARTICLE.

Ciovacco Capital Management, LLC is an independent money
management firm based in Atlanta, Georgia. CCM helps individual investors and
businesses, large & small; achieve improved investment results via research
and globally diversified investment portfolios. Since we are a fee-based firm,
our only objective is to help you protect and grow your assets. Our long-term,
theme-oriented, buy-and-hold approach allows for portfolio rebalancing from
time to time to adjust to new opportunities or changing market conditions.